Johnson Controls International plc

Good morning and welcome to the Johnson Control's first quarter 2024 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note, today's event is being recorded. I would now like to turn the conference over to Jim Lucas, Vice President, Investor Relations. Please go ahead.

Good morning, and thank you for joining our conference call to discuss Johnson Control's first quarter fiscal 2024 results. The press release and related tables that were issued earlier this morning, as well as the conference call slide presentation, can be found on the Investor Relations portion of our website at johnsoncontrols.com. Joining me on the call today are Johnson Control's Chairman and Chief Executive Officer, George Oliver, Chief Financial Officer, Olivier Leonetti, and newly appointed Chief Financial Officer, Mark Van Diepenbeck. Before we begin, let me remind you that during our presentation today, we will make forward-looking statements. Actual results may differ materially from those indicated by forward-looking statements due to a variety of risks and uncertainties. Please note that we assume no obligation to update these forward-looking statements even if the actual results or future expectations change materially. Please refer to our SEC filings for detailed discussions of these risks and uncertainties, in addition to the inherent limitations of such forward-looking statements. We will also reference certain non-GAAP measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are contained in the schedules attached to our press release and in the appendix to this presentation, both of which can be found on the investor relations section of Johnson Control's website. I will now turn the call over to George.

Thanks, Chairman. Good morning, everyone. Thank you for joining us on the call today. Now, let's begin with slide three. We are gaining momentum as we exit the first quarter. Our team has been unbelievable in managing through the recent cyber disruption, which occurred early in the quarter. While it is challenging to comprehensively quantify the overall business impact as we recovered from the incident, we are back on track. In fact, over the course of the last 120 days since the cyber incident, We have connected with many of our key customers, solidifying already strong relationships and strengthening their trust and confidence in Johnson Controls. It is clear from their feedback that our value proposition continues to resonate and customers believe in our products and services. As we enter the new calendar year, we are seeing positive signs. During the quarter, we delivered solid first quarter results, generally in line with our forecast. The fundamentals of our business are strong, as we met expectations for sales, margins, and adjusted EPS in the face of headwinds from the cyber disruption, ongoing weakness in global residential HVAC, and significant slowing in China. Olivier will discuss the details of our financials more specifically later in the call. Looking forward, we expect fiscal 2024 to return to more normalized seasonality in our businesses and the operating environment to be more in line with what we saw prior to the pandemic and recent supply chain disruptions. Our position of building a leading digital building solutions platform continues to be core to our strategy, and we are pleased with the strength of our applied HVAC business, especially as we serve the fast-growing data center market. We are updating our fiscal 2024 guidance today, reducing the full year adjusted EPS range by five cents, reflecting growing headwinds in China. Our commercially focused portfolio and long cycle backlog driven businesses, in addition to our record backlog, gives us more clarity of improvement as fiscal 2024 progresses. Before we continue, I would like to take the time to thank Olivier for his partnership over the last few years and wish him the best of luck in the next chapter of his career. When Olivier informed me that he was taking a role outside the company, we implemented our internal succession plan, and I am very pleased that Mark Van Diepenbeek is assuming the role of CFO. Mark has been with Johnson Controls for nearly 20 years with increasing responsibility in finance roles, including CFO of Building Solutions North America. Last year, we moved Mark into an operating role as president of Amela. Mark brings deep finance expertise, an understanding of our customers, global markets, and operational knowledge. I am confident that we will continue to build on the foundations already in place, and I look forward to partnering with Mark in his new role. Now turning to slide four. I'd like to highlight the strong foundation of operational excellence that Johnson controls in our value creation framework. We are capturing the secular trends across sustainable and healthy buildings. We have the right strategy and operating system in place to create value for our shareholders. And as part of our commitment to discipline capital allocation, we remain focused on deploying resources to the right opportunities. Our team has made great progress the last two years creating a digital services model, and our investments have been a key enabler. The addition of FM systems gave us increased capabilities to serve our customers as they improve their workplace environments. Digital is a strong enabler to creating recurring revenue, retaining customers, and supporting higher sustainable service growth rates. Within service, we are changing the game from deploying a mechanical contractor to creating multiple options for our customers. We are increasing job size, improving margins, and creating scalable solutions. In addition, we are maximizing value creation through digitally enabled offerings and accelerating our lifecycle solutions entitlements across all of our domains. Our team's model has a strong foundation, and we will continue to accelerate the pace of change. At the same time, we have successfully removed many layers of cost across the organization, but we know there is more work to be done. We serve an incredible market, and it is on us to capitalize on the opportunities in front of us. We will continue to simplify and standardize across our portfolio. As we continue to focus on simplifying the company, we are always assessing opportunities to advance our transformation into a comprehensive solutions provider for commercial buildings. As part of the continuous evaluation of our portfolio, we are in the early stages of pursuing strategic alternatives of our non-commercial product lines in line with our objective to maximize value to our shareholders. We are very excited about our future and are confident we are on the right path to simplify our portfolio, drive margin expansion, deliver consistent cash flow while serving our customers in the best possible way. I will now turn the call over to Olivier to go through the financial details of the quarter.

Olivier? Thanks, George, and good morning, everyone. Let me start with the summary on slide five. As George discussed at the beginning of the call, our team did an incredible job responding to the cyber incident. The disruptions we experienced during the quarter were factored into the guidance we provided last month. Total revenue of $6.1 billion was flat year over year, while organic sales were down 1% as continued declines in global residential HVAC and accelerated weakness in China's installed business more than offset mid-single-digit growth in service and continued growth in applied HVAC. Segment margins declined 90 basis points to 12.8% impacted by tough comps in our shorter cycle global product business, coupled with ongoing weakness in China's macro environment. Adjusted EPS of 51 cents exceeded our guidance of 48 to 50 cents as we returned to more normalized seasonality. The quarter was impacted by lost momentum from the cyber incident, accelerated weakness in China, and tough comps in our global products business. Below the line, we saw headwinds from net financing charges due to high interest rates and increased debt levels in line with historical trends. On the balance sheet, we ended the first quarter with approximately $1.8 billion in available cash and net debt increased to 2.2 times which is within our long-term target range of two to two and a half times. The elevated cash position was a direct result of proactive action to mitigate the potential impacts of the cyber incident on cash flow. Adjusted free cash flow improve $180 million year over year, and we anticipate further improvement as we progress through the fiscal year. Let's now discuss our segment results in more detail in slide six through eight. Beginning on slide six, organic sales in our global product business declined 1% year over year with volume declines offsetting price. Global products saw continued strength in commercial HVAC, which grew low single digits after growing low double digits in the comparable period one year ago. We have been investing in our applied HVAC business for the last couple of years, deploying resources to align to more attractive opportunities, resulting in further share gains in calendar 2023. Finance security declined low single digits. We believe that the majority of the tough year-over-year comparisons in the shorter cycle and direct business have bottomed out, and we should see a return to growth in calendar 2024. Industrial refrigeration had another strong quarter, growing over 35%, driven by E-MILA. Global residential declined high single digits, driven by a greater than 20% decline in North America, which more than upset low single digit growth in rest of world. North America continues to face market softness, and we believe we have one more quarter with these challenges before the industry begins to see growth in the second half of the year. We're improving our North America market share and see momentum building. Despite ongoing weaknesses in the European heat pump market, the rest of the world benefited from strong growth in Japan. Our B2B business continues to normalize with improved lead times and our global product third-party backlog decreased 10% from the prior year to $2.3 billion. Adjusted segment EBITDA margins declined 240 basis points to 17.9% as we benefited from insurance proceeds from a warehouse fire in the comparable period last year. We're beginning to see better cost absorption in our factory and expect global products margins to improve throughout the rest of the fiscal year. Moving to slide 7 to discuss building solutions performance. Orders increased 1% as mid-single-digit order growth in North America and E-MILA was more than offset by a greater than 30% decline in APAC, which was primarily the result of further deterioration of the China installed business. As the China real estate market continues to weaken and the outlook remains mixed, we have begun to optimize our go-to-market strategy and have become more selective in the business we pursue. Organic sales were flat in the quarter against a tougher comparison of low double-digit growth in the prior quarter. Install declined mid-single digits and more than offset mid-single digit growth in service. Segment margins declined 10 basis points as accelerated weakness in China offset positive mix in the quarter. Building solutions backlog remains at record levels, growing 7% to $12.1 billion. Service backlog is flat and installed backlog grew 8% year-over-year. Let's discuss the building solutions performance by region on slide 8. Orders in North America increased 6% as we continue to see strong demand across our HVAC and controls platform, growing high single digits, following heightened growth in the comparative period a year ago. Overall, there was broad-based demand in our healthcare, data center, government, and education sectors. Install orders increased 9% year-over-year with solid growth in both new construction and retrofit. Sales in North America were up 4% organically with strong growth across our HVAC and controls platform, up low teens year-over-year. Our install business grew 4% with continued momentum in new construction, up over 25% year-over-year. Organic sales in service grew 4% in a quarter, benefiting from high single agent growth in our recurring revenue contracts. Segment margins expanded 20 basis points year-over-year to 11.5%, driven by the continued execution of higher margin backlog and strength in our higher margin service business. Total backlog ended the quarter at $8.4 billion, up 11% year-over-year. In Imila, orders were up 5%, with continuous strength in service up 12%. Demand in institutional gained momentum in the quarter, growing 50% year-over-year, driven by public projects in Europe. Industrial refrigeration had another strong quarter, with greater than 45% growth. Sales in Imila grew 2% organically, led by high single-digit growth in service with high single-digit growth from our recurring contracts and strong double-digit growth in our shorter cycle transactional business. Applied commercial HVAC and finance security grew low single-digits within the quarter. Segment EBITDA margins of 7.7% remained flat as the growth in service was offset by the conversion of lower margin installed backlog. We anticipate strong margin expansion in eMILA through the remainder of the fiscal year. Backlog was up 10% year-over-year to $2.4 billion. In Asia Pacific, as I mentioned earlier, orders declined 31% due to further deterioration of the China installed business and we're being more strategic in the deals we select. Overall, APAC 7 orders grow low single digits driven by high single digit growth in our shorter term transactional business. Sales in the Asia-Pacific declined 21% as the installation business was impacted primarily by accelerated weakness in China. Our service business grew 5% in a quarter. The weakness in China's install business was broad-based across the overall portfolio with HVAC and controls down 18% and fire and security down 20%. Segment EBITDA margins declined 140 basis points to 9.1% as weakness in China offset positive mix in our service business. Backlog of $1.3 billion declined 21% year over year. I would now like to turn the call over to Mark to discuss our second quarter and fiscal year 2024 guidance. Mark.

Thank you, Olivier, and good morning, everyone. Before I discuss our guidance on slide nine, I want to say how excited I am for the opportunity to partner with George as we simplify and transform Johnson Controls into a comprehensive solution provider for commercial buildings. We exited our first quarter with a cyber incident behind us, and the momentum we lost at the start of the year has recovered. We enter the second quarter with a backlog that remains at historical levels. a healthy pipeline of opportunities, and strong momentum in our industry-leading service business. We are introducing second quarter sales guidance of approximately flat year-on-year, which assumes continued weakness in China and global residential HVAC. We expect strong contribution from North America and Emila, led once again by our resilient service business. As we return to seasonality more in line with historical patterns, global product has one more challenging quarter before stabilizing in the second half. For the second quarter, we expect segment EBITDA margin to be approximately 14.5% and adjusted EPS to be in the range of 74 to 78 cents. For the full year, we continue to expect the top-line growth of mid-single-digit led by stronger performance in North America, further improvement in Emila, stabilization in global product, and a cautious outlook on China. We expect segment EBITDA margin to expand approximately 50 to 75 basis points for the full year, as price costs remain positive and mix continue to improve throughout the year. As George mentioned earlier in the call, given the weakening macro outlook in China, we are updating our adjusted EPS guidance range to approximately $3.60 to $3.75. The overall guide assumes a return to normal seasonality, second-half stabilization of global products, and a conversion of higher margin backlog in building solutions. We continue to expect adjusted free cash flow conversion of approximately 85% for the full year. The improvement we saw in cash flow for the start of the year demonstrate that our working capital improvement are gaining momentum. With that, operator, please open up the lines for questions.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. In respect of time, we ask that you limit yourself to one question and one follow-up question. At this time, we will pause momentarily to assemble our roster. And today's first question comes from Scott Davis with Milius Research. Please go ahead.

Hey, good morning. Good morning, guys. Can you hear me okay, hopefully? Yeah, good morning, Scott.

Can you hear us?

Yeah, fine, thanks. George, I think, you know, it's been a tough couple quarters. Maybe if we take a step backwards, you know, what do you think long-term, this portfolio, the growth rate and margin levels and the cash generation, what is kind of your, you know, I don't want to call it dare to dream, but what is the vision of where you think you can get you know, two, three, four years down the road when, you know, in a more normalized environment.

Yeah, so let me start, Scott, by just saying that, you know, as you know, we've been through a significant transformation here into becoming a comprehensive solutions provider for commercial buildings. And then as part of that, you know, continuing to focus on how do we transform the business model and how we bring our differentiated solutions to our customers in the commercial space. And so as you look at what we've been doing, we're well positioned to invest and lead in the overall building solution space, capitalizing on significant secular trends, sustainable buildings, smart, healthy buildings. We've been allocating our resources and building out the capabilities. When you look at the content of how we differentiate the solutions, it's not only through the leadership of the product, the applied product and continued investment that we're making in product, but also now deploying those products with a leadership platform with OpenBlue that we believe is going to now lead the industry. And that all is converting into how we change the outcomes for the customers that we serve. And that's through our engineered commercial solutions and converting what we do within building solutions to a digitally enabled service. So when you look at the margin structure as we go forward, not only are we getting a more focused approach to the differentiation with the value proposition right from engineering through install to then ultimately getting the lifecycle services. When you project the overall performance going forward, we believe that from a growth standpoint, we'll be well above market on capitalizing on the secular trends with the differentiation that from a margin profile, we'll have a much higher recurring revenue within our services, demanding a much higher margin with the content of the software enabled services. And then from an overall return, you know, when you look at the conversion to cash, we're getting now for the value proposition we bring, we're getting much more cash up front relative to that value proposition and ultimately being able to deliver a very strong free cash flow. So I would say well above market growth, continued expansion of margins to what we believe is kind of mid to higher teens. and then very predictable cash flow with the mix of the content of what we do for our customers.

That's helpful, George. And when you think about asset sales, you know, and there's some nuance here clearly, but is it more a function of simplifying the portfolio so you can execute on those KPIs that you just mentioned, or do the asset sales themselves kind of change the growth and margin profile of the company?

Yeah, let me reflect on the transformation that we've been going through. We've been continuously evaluating the portfolio, kind of where we are with the transformation of a comprehensive solutions provider and commercial buildings, and then making sure that our resources are being deployed to the highest priorities. When you look at the non-commercial product lines, they're excellent businesses, but they do not necessarily, are they consistent with the go-forward strategy over the longer term? And that's now why, as we are now pursuing the alternatives here, because these are good businesses, and there's an opportunity with these businesses now to be able to create even more value for our shareholders as we look at the alternatives. We're very excited about the future with the prospects that we have and the opportunities that we're driving towards. We believe that we're on the right path now to simplify the portfolio, continue to drive margin expansion, deliver much more consistent cash flow, while most important is really differentiating the value proposition that we can bring to our customers, which is going to be fundamental to the growth.

Thank you. And our next question today comes from Steve Tussaud with JPMorgan. Please go ahead.

Hi, good morning.

Good morning, Steve.

It would be great if Mark could answer this question, but for the second quarter, could you just talk about the various segments and how you get to this, you know, 14.5% operating margin target maybe on a year-over-year and sequential basis and what you expect out of them? And I have a follow-up. Thanks.

Yeah, thanks, Steve. So first, I want to address the change in guidance, right? Since we issued our guidance in December, the impact of the economic environment in China on our business has deteriorated. And we had factored originally a fairly cautious outlook in China in the initial guide. However, that outlook has further worsened. We refocused the organization going through that tumultuous environment in China, and we see a path of recovery to that volume and recovery of the backlog as well in the second half of the year, but it started to bottom out in Q2. we have more clarity on some of the actions we've taken around productivity and cost structure, and that supports the recovery in that backlog. Now focusing on Q2 on the different business, if you look at our field-based business building solutions, the cyber disruption is really behind us, and the lost momentum that we had in Q1 is now recovering and supporting the shorter cycle businesses, particularly our service mix. If you look at North America and Emila particularly, the margin we have put in the backlog over the last six months, but particularly during the first quarters, gives us confidence that we're going to be able to deliver on the margin rate for those businesses. There's a lot of benefit of cost actions we've taken early on in the year and later last year, but there's also more return to seasonality in our global products business as we see the volume providing margin in those operations. If you combine all of that, I think we see with confidence that margin being attainable, Steve.

Okay. And then just, George, for you, I guess, you know, it's kind of hard to reconcile the commentary on momentum in your strategy with, you know, basically negative organic growth this quarter. Do you consider that, Steve? you know, positive momentum? And then secondly, what drove the timing on this announcement of evaluating strategic alternatives? I mean, it's not like you have anything really lined up here, you know, official to announce. So why are we kind of just throwing this out there today versus maybe, you know, over the last couple of years where you've been kind of pursuing the same strategy and You know, just curious on a kind of a straightforward answer on both of those. We don't need a lot of verbiage. Thank you.

So let me just comment on the quarter as far as momentum. We did have a significant disruption, as Mark said, for about six weeks of the first quarter. And part of that did have an impact on our momentum and our ability to be able to convert and the like. And so that was more of a short-term impact in Q1 in addition to the year-on-year adjustment that we've had in global products. As far as the timing, I'm sure you can appreciate, Steve, the board and the management team. We've had a very thoughtful approach to the strategy. We assess all avenues that will deliver value to our shareholders. Our strategy, our transformation has been focused on really leveraging all of our combined strengths in our differentiated product, our digital platform, and then from a go-to-market standpoint, the depth and expertise strategy. that we have from an engineering standpoint to ultimately be a comprehensive solution provider and our ability to be able to take the value proposition and be able to convert that to recurring revenue through services. We're seeing that momentum, which is beginning to convert. And as we look at the difference in the business models within the businesses, when we talk about the non-commercial businesses, there is a different business model relative to how we serve the market. And I think this allows us to be able to position those businesses for continued growth while we're creating value, while we're focused on really now accelerating the progress we've made within our building solutions business.

Thank you. And our next question today comes from Jeff Sprague with Vertical Research. Please go ahead.

Hey, thanks. Good morning, everyone. I wonder if we could just drill a little bit more, George, into kind of the portfolio review. And specifically, as you know, the business is complex day to day for you running it. It's even more complex for us on the outside looking in. So can you just size for us what we're talking in non-commercial assets? I think you know I put an estimate out there. I don't know if I'm in the ballpark or not. Just give us some sense of the, you know, the total revenues that we're talking about that are under review and consideration and, you know, maybe kind of the average profitability across that basket.

Yeah, when you look at the overall revenues of these businesses, it would be less than 25% of the portfolio.

And how did the margin stack up versus the average or JCI?

Overall, when you look at the mix of the margins, it would be in line with the overall JCI. Okay.

And then just kind of coming back to maybe more a granular point on this then, you know, even preceding you, I think as you well know, there was always this debate about You know, can you extract resi from kind of legacy, you know, York, the resi and the light commercial applied or tied together? And, you know, maybe it undermines your, you know, your larger commercial effort, you know, if you, you know, if you exit that business. I mean, maybe you've found a way to separate resi and light commercial where you think you can, but can you provide any, you know, any additional context on that and how the light commercial business in particular might factor into your strategic thoughts on where the business goes from here.

Sure. So if you look at Resi Light Commercial, and the businesses now are really back on track. I mean, we've had a really nice quarter here, picking up share both in Resi as well as Light Commercial. Business in North America was up double digit, which was supported with 40% growth in commercial, and with Resi being down about 7%. So businesses now are performing, positioning to perform going forward. On the ductless side, when you look at JCH is where we had strengthened in Japan, offsetting some of the weakness we saw in Europe and India. So when you look at the go-to-market, I think it's important to understand that these non-commercial product lines are excellent businesses, but when you look at the go-to-market, they're not consistent with what we're doing as we build out our building solutions over the long term. And so we believe that when you look at the value proposition that we bring with our customers, that although there's an overlap with some of the applied rooftops, that can be managed with the structure that we put into place going forward. And so I think when you look at the, it does not erode any value proposition in our comprehensive commercial solutions, but also positions the business to be able to take an incredible asset and create more value through growth.

All right. I'll leave it there. Thanks. Thank you.

And our next question today comes from Nigel Coe with Wolf Research. Please go ahead.

Thanks. Good morning. So, another question on the portfolio review. So the press release on Friday highlighted Hitachi, but also talked about residential-like commercial for York. And I just want to make it very, very clear that we're talking here about just the U.S. residential assets. But there's also a mention of the ADT business as well. So any more color in terms of the non-commercial assets, because it does feel like there are some commercial businesses here. And then on the Hitachi side, obviously Hitachi still has 40% of that business. How much flexibility do you have to seek options for your majority control of the asset?

I think you'd appreciate, Nigel, at this stage with the ongoing transformation, I would caution against making any assumptions at this stage and how we will affect it. I think the communication here today is that we are pursuing strategic alternatives. We're going to continue to simplify and standardize across the portfolio. But we're in the early stages, and at this stage, I'm not going to comment relative to any one of the potential assets that we would look to create value with.

Okay. Worth a try, though, wasn't it? But if we do assume that you execute on some form of strategic realignment to the portfolio, if you had, let's say, $5 billion of cash coming in the door today, how would you look to deploy that, George?

As we look at, I mean, we're again speculating on, you know, what would happen. I think as we look at what we do within our comprehensive commercial solutions business, we have been doing bolt-ons. We'll continue to be able to do bolt-ons and supporting the technology in our go-to-market as we strengthen that across the globe. And our intent would be to make it accretive, you know, as far as whether it be through bolt-ons and or deployment back to our shareholders. to offset the dilution that any divestiture might have. Okay. I'll leave it there. Thanks.

And our next question today comes from Noah Kay with Oppenheimer. Please go ahead.

Great. First, a shorter term one. You know, you did mention signs of bottoming out in fire and security on the short cycle. Can you just give us some more indicators and confidence there?

Yeah, when you look at the business, whether it be at the product level or in the field, as far as the demand signals are coming through strong, we've gone through some adjustment relative to backlog as well as in the product business, the book to build business. We see this really differentiating our overall commercial solutions and how we're utilizing these businesses and differentiating our solutions. On a go forward basis, we have When you look at our pipeline of opportunities, it's pretty robust. And we're working to continue now to execute that into backlog and ultimately then conversion, you know, revenues going forward. So I think it's more short term based on what we've seen here with some of the adjustments in the market. But we're confident that with the pipeline we have, we're going to be positioned to be able to continue to support the growth that we're committing to.

Okay, thanks. And I think I'd like to return to the why now question that was asked earlier, and maybe frame it slightly differently. You know, that obviously, the US market went through a tough year last year with volume trends. But certainly, there's some some secular tailwinds as we look out in the next couple of years of refrigerant transition, you know, ongoing price mix benefits, easier comps, and then you have the transition both in North America and globally towards heat pumps. You know, there seem to be some positive prospects, you know, North American globally for residential. And at the same time, you know, there's an overarching concern for many investors around, you know, non-res, right, commercial weakness. And so I guess in that context, you know, why now is, particularly acute question because I think from a cycle perspective, the market doesn't necessarily see the same trends ahead that would seem to inform this decision. So if you kind of talk to us about why this makes sense for you and why now.

Yeah, so as I said earlier, you know, we've come through a very disruptive period and there's been significant progress that has been made across these businesses and these businesses are positioned to perform. And so, as I said earlier, as you can appreciate, we're constantly reviewing the portfolio and understanding how we manage the assets to be able to deliver value for our shareholders. We've taken a very thoughtful approach to the strategy, and this has been continuous in making sure that we're assessing all avenues on how we ultimately deliver value to our shareholders. And so, that's what's been playing out. And I think tied to, you know, as we think about our our acceleration of becoming the leading comprehensive commercial solutions provider within commercial buildings, this is part of that path forward. And in line with, you know, consistent with, you know, how we continue to update our shareholders, we'll continue to provide those updates as we continue to make progress with these potential divestitures.

I appreciate that thoughtful answer. Thanks, George.

And our next question today comes from Joe Ritchie with Goldman Sachs. Please go ahead.

Thanks. Good morning. Congratulations, Mark and Olivier. We'll see you on the other side. Thank you. Let me just start with Asia because you referenced China a few times on your prepared comments. I'm just trying to understand how much of the weakness that you saw this quarter was just the market deteriorating versus your own selectivity? And then as you kind of think about the next few quarters, should we be expecting material order declines to continue?

I'll take that, Joe. Last year, when you look at where we were last year, we were working to recover our backlog from the second wave of COVID shutdowns in China. You know, as the economic environment in China has slowed, we continue to make sure that we're streamlined with our organization and aligning our resources to the market to be able to maximize what we believe is our entitlement and then make sure that we're executing with discipline to achieve what we see to be very strong lifecycle value creation with our services. This is what we've played out in North America, which has been very successful for us. You know, we do have a very healthy pipeline as we assess the market, which we are converting. We are anticipating a slower recovery of the backlog and ultimately the projected revenue, which now has been pushed to the right. And so those are the factors really updating our guidance there, Joe, but confident that we You know, we have incredible product for the market, making sure we have the right go-to-market structure, and then ultimately being able to execute on what we see still to be a very attractive market.

Okay. Thanks, George. And I know that you don't want to provide a ton of specificity on what non-commercial means. Just maybe for my own edification and remembering that the old Tyco assets, I mean, I think you still had some residential ADP international assets as well. So just correct me if I'm wrong, if you don't. And then also just a point of clarification, the light commercial business is showing at roughly 6% of sales. I think the last several quarters, we've been seeing it closer to 9%. Did you guys shift portion of the light commercial sales into applied? Just want to understand that a little bit too.

When you look at the mix within our ducted business, which is mainly what drives our light commercial, is we're up 40%. And like I said, in our ducted business, when you look at resi being down slightly and then commercial being very strong, our whole ducted business was up 10%. And so this has been the differentiated product that we've been bringing into the market. We've increased share, Joe, by been roughly about 300 basis points over the last year with the recovery of the commercial market. And we've invested in the capacity to be able to do so. So as far as that is the core of our like commercial business, and we've been performing extremely well.

So was there a reclass? Because it's showing like that business is lower as a percentage as your total sales than it was in the last few quarters.

It takes into account the VRF.

No, Joe, the difference is that the 9% is off fiscal 22 sales in the prior year versus when we move forward. It's now off fiscal 23 now that that year is final. It's just a math exercise.

Yeah. Actually, that math doesn't really tie well, but I can follow up offline. Thank you.

And our next question today comes from Andy Kaplan with Citigroup. Please go ahead.

Hey, good morning, everyone. Good morning. Could you give us a little more color regarding your order cadence within building solutions and what you're seeing? Obviously, most of the slowdown orders, as you said, in Q1 was because of the slowdown in China. But did you see a dip in orders because of the cyber incident and then improvement? I think you changed your incentive comp structure for some of your salespeople as well in the quarter. So a lot going on. How are you thinking about orders and backlog from here?

Yeah, so as we talked about, we did lose some momentum because of the cyber incident. And so when you look at the sales conversion cycle, it did lengthen in the first quarter by about a week, a little bit better than a week. And so when you look at our pipeline, continues to expand and does support the acceleration of orders in Q2 and through the remainder of the year, in line with what we were projecting prior to having the impact that we had So we're very confident that with the pipeline, with the generation, pipeline generation, and then our ability to be able to convert with the cycle times we convert with, we're back to where we were. And then that also being combined with our success in services and being able to continue to build strong pipelines for services, convert to PSAs, building backlog, and then ultimately supporting our ability to get services, deliver high single digit services for the year.

Thanks for that, George. And this question might be for Mark. I know you ran building solutions in Mila at least for a little while. So obviously those margins have continued to be challenging. Can you give us more color into what is holding down that segment, projects ending there and maybe better margin going forward? And then talk about the changes you began to institute and when they might have more impact on that segment.

Oh, great question. Right away when I took the role last year, we started to work on implementing our enterprise field operating model. That's very similar to what we did in North America a few years ago. You know, Johnson Controls operates in markets that are very sizable and complex, but that provides ample opportunity for us to grow. But when you face large market, it's important to remain focused and disciplined on the subsegments of that market that provide the right level of product capabilities, leverage of engineering talent, and our solutions. And we are looking for those subsegments of the market that provide the most value for both our customer and the company. As we continue to simplify, standardize, and I would say rationalize that business, the operating model becomes easier to adopt in the field, in the regions, and the benefits of that model get amplified. We get a lot of leverage. And that's really what we've been focused on over the last six to eight months. There's still work to be done, but I see great improvement in our book margin. And as we start seeing the benefit increase, of that model and the actions we've taken. So I'm very confident that Emila will return to comparable profit level that the other field segment are seeing. Appreciate the call, guys.

And our next question today comes from Julian Mitchell with Barclays. Please go ahead.

Hi, good morning. And, you know, thanks, Olivier, and congrats to Mark. Maybe just on slide nine, the guidance for the sort of existing portfolio. So you're looking at sort of 4% organic sales growth, let's say, for the year. So the second half is implied up eight. How should we think about that plus eight splitting between global products and then building solutions? And just trying to confirm, does that second half growth guide of plus eight include growth in both U.S. Resi HVAC and also China building solutions? Thank you.

Yeah, so thank you. So as you look at the breakdown between our business solution segments and global products, we see a recovery in growth in our Asia pack in the second half of the year. So that will turn positive. And as we continue to see the other segment, BSNA and North America and Emila, continuing to clog at mid-single digit, you can see the balance of those two offsetting and getting very strong single digit all the way to almost double digit in the second half of the year. That supports the growth you're seeing on the slide. When it comes to global products, we continue to see an improvement in orders. As we said, we believe that Q2 is really the bottoming out and the stabilization of that business. And we see quite good momentum in the recovery into Q3 and accelerated into Q4, supporting that number you see on the slide.

Got it. So both GP and Building Solutions grow at a similar rate in the second half to each other. That's right. Thanks. And then just a second question. I understand you can't talk too much about the portfolio, so maybe thinking about some other items. Just wanted to mark on the perspectives on sort of receivables factoring from here and what the approach will be in terms of does that factoring get unwound now because lead times are going back to normal. And, you know, pillar two has come in. So should we think about the medium term tax rate moving up to the high teens? Thank you.

Yes. So starting on that last question on tax rate, obviously there's some headwinds there with the changes in the rate. We are continually assessing it and we'll continue to look at it. But you're right. There is a headwind longer term on the rate. When it comes to factoring, we always look at different methods to finance the company. And as you said, when lead times got difficult, when inventory were a little bit more elevated than traditionally, factory became a logical avenue. We will continue to review the most economical ways to finance the company. We'll make sure that we take appropriate action against that program to align it with the financial commitment we've made to you, both in terms of profitability and free cash flow conversion.

Thank you. And our next question today comes from Guadamcana with TD Cowan. Please go ahead.

Hey, good morning, guys. Good morning. I was wondering if you could comment on pricing in the various verticals, what you're seeing with respect to pricing power, and then I have a follow-up.

Yeah, as part of that simplification of our business model, one benefit that comes in, we have more clarity on our cost accumulation and our ability to drive price, focusing the businesses, particularly our business solution segments, towards better vertical and better product lines and solution. We are able to drive more price through the market than we have been historically, chasing less demand the segments of the market where competitiveness but also value is hard to sell to the end customer. So as part of our building solutions operating system, you can see a great improvement both on the price we can command in the market, but also the price realization. We see enough backlog in our executed margins. When it comes to global products, we've always tried to shy away from the more commoditized part of the market. For the parts where we actually have differentiated product, we see tremendous momentum both on pricing, but as well as the margin that comes on the back end of that market. I'm particularly thinking about our applied HVAC businesses that have been operating at a very strong margin over the last few months and continue to see quite good momentum from a price-cost standpoint.

And could you expand that commentary on the resi market as well? Are you still able to get prices or any pushback? Are you seeing any evidence of trade downs or movement to resi? Repair versus replace and the like.

As we've said previously, we've continued to lead pricing, making sure that with all of the reinvestments that are being made to support these regulatory changes that we're positioned to be able to get the proper price. And that continues. And so in spite of us being maybe not one of the top players, we've been very disciplined relative to how we're creating the value proposition and ultimately how we're pricing in the market.

Thank you. Thank you. And our next question today comes from Chris Snyder at UBS. Please go ahead.

Thank you. So for revenue, you guys are guiding March up about 10% sequentially, which is a good deal stronger than the typical mid-single-digit ramp that we see most years. Maybe can you just talk about the drivers of this sharp increase into the March quarter? I understand there's a couple points of cybersecurity catch-up, but it sounds like GP maybe has yet to stabilize. I think you said it troughs in the March quarter, so I'd expect some headwinds there still remain. Thank you.

Yeah, it's coming, and I think you mentioned it in your question. There's some return to normal seasonality versus the prior year. As we were flowing through the backlog, you can see that seasonality picking up, and that's lifting us a couple points. But you're absolutely right. The cyber disruption and the loss of momentum it had created in the quarter, there were very few orders that were lost, but the cycle time of our commercial team expanded as we were going through the quarter. And that created challenge in the first quarter that now provides still win from a growth standpoint in the second quarter.

And was it one, I know you guys called out one point in the December quarter, if I remember correct, was it one point again from cyber in the March quarter?

I don't believe we were that prescriptive, to be honest with you. It's really hard to measure with precision how much was cyber versus the markets at the time. But I think if you look at the momentum we've built now in Q2, I would tell you it's a few points of benefit that we're seeing.

Oh, got it. Thank you. And then for my follow-up on global products specifically, You know, you guys talked about seeing stabilization. Can you maybe talk about their respective product lines within that, but being resi like commercial and fire and security, are they all showing stabilization or any leading, any lagging on that normalcy? Thank you.

Yeah, when you look at our, you know, the global products and more of the transactional businesses book to bill, you know, we went through a significant inventory adjustment last year in the channel. When you look at our order rates now coming in and now what we're projecting in revenue, we're seeing that positive across the board. Again, in the deductive business, resi is still down about 20%. With price, we're down single digits. That'll continue to improve as we go through the year. But beyond that, across the board, we're seeing very strong orders in line with what we're projecting for revenue as we go forward. Thank you.

Thank you. And our next question comes from Nicole DeBlaise with Deutsche Bank. Please go ahead.

Yeah, thanks. Good morning, guys. Good morning, Nicole. So we've covered a lot of ground here. I guess the last thing I just wanted to ask about is, I'll just keep it to one question, is, you know, you guys gave guidance and reported earnings obviously pretty late in the fourth quarter with only a couple weeks to go. So... how did China take you by such a surprise where we're only, you know, a month later and we have to cut guidance by five cents? Thank you.

Yeah. You know, the disruption that came from the cyber incidents also slew down the pace at which data flows through flows through the organization. And, As I mentioned in the opening remarks, we had factored a fairly cautious outlook on China, but our ability to really pin down exactly the impact it was actually going to have in the current quarter and following quarter. As we all know, about six weeks, smarter and more educated about the challenge and that outlook has worked on further. We discussed it in a prior question. It's a combination of the market condition and us being more selective in the type of deal and the type of transaction we decide to pursue.

Thank you. And our next question comes from Joe O'Day with Wells Fargo. Please go ahead.

Hi. Good morning. In your reference to simplifying and standardizing costs across the portfolio, I think you've been on some kind of notable cost out as it relates to both COGS and SG&A. Is this sort of setting up for the next chapter, or can you talk a little bit about where you see the biggest opportunities on simplifying some of the cost structure and any sizing of those opportunities.

So let me reflect on that. I mean, we've been through a major transformation taking a set of businesses that were, you know, a lot of variation in the fundamentals within the operating system. We now have standardized that. across the board. That has allowed us to become much more efficient, reducing layers and ultimately the cost that is required to support the business. As we continue now, so it's twofold, not only standardizing the processes, but then with automation and IT supporting those processes with good data, that has all accelerated within the company, which has allowed us to be able to now capitalize on more simplification That's one element. And then from a selling standpoint, as we then standardize our operating system around commercial, we've also been able to align our commercial resources in line with the market, with the segmentation that we're driving to be able to drive our growth. And we're seeing significant pickup there also. So it's really across the board on all of our cost elements. in line with being much more simple, much more standard, and more agile in how we now pursue growth.

And then could you talk about service order trends by region? When we look at Amila, the last couple of quarters we're looking at have low double-digit mid-teens type of growth in service orders in each of those quarters, whereas in North America, we've been seeing low single-digit. So what you're seeing in terms of sort of differences in terms of those growth rates, demand trends on the service order side and field.

Yeah, let me just touch upon the fundamentals, and Mark can talk a little bit about the orders. The fundamentals here, we're increasing our attach rate. So now we're up to mid to upper 40 percentiles. We're getting a more, a higher percentage of our install base served. With this year, we're going to be able to expand our connected assets by well over 10,000. We're going to be able to get PSA growth, longer term services up over 20 percent. And then when you look at The way that we're connecting our services, we're getting much lower attrition rates. That all now is playing out and positioning us for a strong, high single-digit service growth again this year. On the order rates, as we look at any one of those elements, we're consistently driving that strategy across all three regions. Mark, maybe you want to comment.

Yeah, commenting on the three agents. So North America is our largest service business and was also, unfortunately, the most impacted by the cyber disruption. So that's why you see a little bit of softness in Q1. It's a very transactional business, day-to-day business that has a lot of automation and reliance on our system to be able to book orders and execute that revenue rapidly. The fundamentals of that business hasn't changed and I think the recovery is coming in the balance of the year and we're seeing now in the second quarter a really strong pickup in that business. If you look at Emila and Asia, touching on Emila first, those are mature businesses but at a different part of the cycle when it comes to growth. There's enormous amount of opportunity in getting after or install this and continuously maturing our business model similarly to what we've done in North America to really drive long-term double-digit growth in those service businesses. In Asia Pacific, particularly in China, Part of our focus on the market is really focusing on those sub-segment of the market where we see a strong long-term service profile for our business in order for us to really maximize the whole life cycle of those opportunities. Thank you.

Thank you. And our next question today comes from Dean Dre at RBC Capital Markets. Please go ahead.

Thank you. Good morning, everyone. Just a quick question from me, please. Regarding the potential or expected divestiture as a separation of REZI, what would that do to RemainCo in terms of free cash flow potential, just maybe down to the level of working capital? Does that change your ability to hit this target of 100% free cash flow conversion?

Yeah, not at all, Dean. I mean, we've been working on our free cash flow and the fundamentals of that across both the building solutions to be able to get more billing up front and more in line with revenue. And then in our global products business have significantly improved not only the inventory, but also our ability to be able to collect. So as far as the commitment to our free cash flow target, we're going to be well positioned to be able to deliver on that target.

Thank you. And ladies and gentlemen, this concludes our question and answer session. I'd like to turn the conference back over to George Oliver for any closing remarks.

Yeah, just to wrap up, as we've discussed here today, we've been on a transformation journey for a number of years and have made incredible progress and have had many successes. While we're building strong fundamentals, we're also better leveraging our people and portfolio and ultimately serving our customers in a better way. We're very confident we've built a very robust network operating system across the portfolio and are going to be well positioned to deliver for our shareholders. And I do look forward to updating all of you as we continue to make progress. So with that operator, that concludes our call.

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.